Will mortgage defaults lead to a depression?

[sdrealtor]

As I’m prone to do, I occassionally do some back of the envelope calculations to test market hypotheses. Here’s one I just came up with for the piggingtonians to chew on and debate. It may be full of holes so please feel free to plug them!

Lets take a real doomsday scenario and say 25% of all mortgages default across the US. Then lets say that they are all sold at an average loss of 25% to the noteholders. I think it would be difficult to foresee this happening let alone an even worse scenario. Here’s my math.

100% of mortgages X 25% default X 25% average loss on each default = 6.25% loss on the value of all mortgage loans. My guess is that the average yield on mortgage loans is roughly equal to that. Based upon this, we are looking at a worst case scenario of the loss of 1 years interest on the entire portfolio of loans. Not what I would consider a doomsday situation likely to cause a depression.

Hack away at it!

[blahblahblah]

Who’s going to buy all of those foreclosed homes, even at 25% off? The $600K house is now $450K. Here in SD, that will still be out of reach of many first time homebuyers, assuming we return to the standard of 20% down, fixed rate mortgages. Maybe there enough first-time buyers renting right now with $100K ready to spend on a down payment/closing costs, I don’t know. Or maybe everyone is just going to use option ARMs from here on out. Perhaps if incomes go up between now and the time this plays out, a 25% maximum drop is possible. Of course if incomes are rising, we will have inflation which means interest rates are likely to rise as well which means payments will go up which means… Well, you get the idea. Also, if interest rates go up, are people going to want to use their $100K as a down payment when they could just buy CDs and collect interest? Certainly no one is going to be counting on home appreciation for a while, the group psychology will have been spoiled by the bubble casualty stories just now beginning to hit the news.

Who knows? It’s interesting that the question is now not, “are home prices going to drop?” but rather “how bad is this going to get?”

[sdrealtor]

Concho,
You are a bit off the mark. A depression has to be on a national level not locally. My example addresses the issue on a macro level nationally. Please try ot stay on point.

SDR

[powayseller]

The total mortgage debt in the US is $9.1 trillion (2005).

10% of all mortgages will reset in 2007.
“The Federal Reserve estimates that 20% of outstanding mortgages have variable rates. Half of those are set to change interest rates this year, Fed Chairman Ben Bernanke told lawmakers earlier this year.”

$9.1 trillion x 6.25% = $ 568 billion in losses, assuming you can sell the house at a 25% average loss. In the last downturn, just one bank in LA had 560 houses on its books that it could not sell, because there were not enough buyers. My friend was a realtor in LA at the time, and she managed those properties and rented them out. Then over time, as the market picked up, they started selling small groups of those homes. These were nice homes, in Laguna Niguel, in Pacific Palisades, on the beach. There were no buyers at the bottom of the market. Some homes were just boarded up until the market turned around. So we can’t assume the bank will get back 75%. They may end up holding the house for *years*.

Also, let’s add the unearned interest income that is on the books of the “stupid banks”, the ones that did not offload the risk to the MBS (mortgage backed securities) market. Washington Mutual has, by my estimates, $ 1 billion of unearned interest income that is will not get, not ever get in my opinion. When they take that $ 1billion or greater loss in the next few years, I shudder to think of the fallout. Think back to the 1980s S&L bailout and multiply by 10 or more.

However, the biggest problem from the housing bust will be the rising unemployment as we lose 1/3 of all jobs created since 2000 (since they are real estate related), the ripple effect to corporations and the stock market. Think about Home Depot, Shaw Carpet, Pacific Kitchen Sales, all those lumber yards, copper and other commodities, stock market, credit card companies… they are all going to take big losses.

The rising unemployment rate will put extra burden on the government for social assistance at a time their own revenue from property taxes and sales taxes is shrinking. The Voice of San Diego just had an Opinion piece this morning about Chula Vista’s unreasonable promises, based on a forecast of ever rising property taxes flowing to their coffers. Even Jerry Sanders needs property taxes for SD to grow at 2% annually to meet his stripped down budget. How will San Diego handle 10% annual declines to its budget?

Oh, and another stock market collape, at it loses 30% of its value by next summer, will wipe out even more savings.

What I don’t know is the effect of our reducing housing prices on foreigners’ willingness to keep lending us money. If they stop, how will that affect our interest rates?

Did I leave anything out?

sdr, nice thread. I’d like to know your opinion on something. How long do you think we Americans can consume more than we produce, why can’t we be more productive, and how will our lives change when we are forced to create that balance?

[sdcellar]

I’m not suggesting we’re headed for a depression (I know far too little to suggest such a thing), but I do think you’re overlooking the ancilliary effects.

Such widespread foreclosure would certainly put extreme downward pressure on home prices across the market. This puts a serious dent in the housing ATM which reduces non-housing related spending.

New home starts would continue to decline (all this inventory is now available), so there would be significant job losses in all housing related fields. Higher unemployment, further reduced spending in all areas.

Reduced spending causes job loss in non-housing related fields, further reduced spending.

It’s never just the one isolated thing, rather cause and effect just as things always have been.

[blahblahblah]

Okay, strike SD from the comments, but the situation here is similar to the one in LA, SF, Seattle, NYC, and probably a few other places that combined, are bound to have a big effect on the US economy. I’m still not convinced that buyers are going to be lining up in droves to buy those properties at 25% off. Maybe in Austin, maybe in Charlotte. Certainly, the loss of the interest from the aggregate of the loans is not that big, as you point out. But what about the loss to the population that has seen their “savings” disappear overnight? What about the lost jobs in construction, mortgage lending, real estate, etc… I don’t know that we’ll see a depression, but I think we may see a realignment of national priorities towards more productive activities than building McMansions in Amarillo…

[powayseller]

CONCHO, you are right. Think about all the people counting on their home to fund their kids’ college tuition and their own retirement. This is just anecdotal, but I’ve had so many people tell me they will sell their home when they retire, and I try to plant the seed that that retirement portfolio is shrinking (and then they change the subject).

[sdrealtor]

I think we can all agree that we are in for some challenging times as a nation. The complexities of analyzing and forecasting the economy are too numerous and dynamic to ever accurately project. I just like to take a top line simple look every once in a while to test what I hear.

[FormerOwner]

Another negative: a lot of people bought houses out in the boonies and were willing to do the commute because their houses were going up-up-up in value. No one will want these houses in the boonies now. The pool of buyers for these houses (and there have been a lot of them built in the last few years all over the country) will be close to non-existant. The banks will not be able to sell them at any price since the market will be illiquid. Defaults will cascade since no one who needs to sell will be able to. In the better locations, houses will still sell, but at much reduced prices.

[PerryChase]

I think that the real estate downturn won’t affect consumer spending enough to cause a depression. Americans have an amazing ability to move on. People will let their houses go before they cut back on their steak dinners and ice cream. Eventually, they’ll say f— it, I’m not going to let the house own me. They’ll walk away and move on.

Actually it turns out that mass foreclosures might be good for the economy because people will put their incomes to consumption rather that debt payments. That is preferable to owners tightening their belts to make mortgage payments.

Holding on to real estate albatrosses is what caused 15 years of stagnation in Japan. The beauty of the American economy is the ability to cut the losses and let better owners manage the looser assets/properties.

I see a 50% drop in real estate prices from the peak but I don’t foresee a protracted downturn in the general economy.

[LookoutBelow]

Do you think mortgage defaults will cause a depression ?

 

YES

To think otherwise is naive. almost 10 trillion in mortgages ? How many of those have to go sour before you see it on a macroeconomic scale ?…then ask yourself, how many of the loans the last 4 years or so were ARM's ?

 

LOOK OUT BELOW 

[Anonymous]

Everytime I contemplate mortgage defaults I find it depressing. Every default is a person, most defaults affect a family – it is usually a painful proposition. I have to admit – I have been moved to tears as I’ve viewed the ads for auctions of multiple homes in the Michigan area — everyone of those properties represents a sad story to me.

My guess – the worse it gets the worse it will get.

I speculate that over a certain percentage of properties that are for sale that are foreclosures the price decline will take off geometrically. I don’t know where that level is, whether it is 4% or 5% but I postulate that it will be somewhat similar to the Richter scale for earthquakes.

Ouch!

[sdduuuude]

“I’m still not convinced that buyers are going to be lining up in droves to buy those properties at 25% off. ”

Remember all those people who sold in 2004, 2005, and 2006 and made 100% on their money in 5 years? They are waiting for it.

I think most of the doom and gloomers forget that for every screwed speculator and late-buyer, there is someone with a wad of cash who sold the house to them in the first place.

It is hard to put a number on the effect of this, but it must be considered and I rarely see anyone on this forum bring it up – ‘cept me.

[PD]

I don’t think there are very many of us who cashed out. Other than those on this board, I only know of only two other people who cashed out. One person was forced to cash out in 2004 because of job loss and need the cash for a new business venture. The other person moved out of San Diego for a three year military tour. After talking to us, they sold instead of renting out their house. However, they would not have sold if they were still living here.

I think most people are holding their breath, hoping the tsunami passes over quickly.

[sdduuuude]

For every house sold, someone cashed out.

[Author]

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